Short-term reversal is the tendency for stocks that performed well (poorly) over the past week to one month to subsequently underperform (outperform). It is the mirror image of momentum, which operates at the 3-12 month horizon.
Key evidence
Jegadeesh (1990) documented significant negative serial correlation in monthly stock returns, with a contrarian strategy (buy past-month losers, sell past-month winners) earning 2.49% per month. Lehmann (1990) found similar weekly reversal profits of about 0.95% per week.
Interpretation
Unlike momentum and long-term-reversal, which have clearer economic stories, short-term reversal is widely attributed to microstructure effects:
- Liquidity provision: reversal profits compensate market makers and liquidity providers for absorbing temporary order imbalances (Grossman and Miller 1988)
- Bid-ask bounce: measured returns bounce between bid and ask prices, creating spurious negative autocorrelation
- Overreaction to short-term news: investors overreact to information at very short horizons, with prices reverting once the overreaction is recognized
Capacity and tradability
Short-term reversal is among the largest raw return anomalies but is largely consumed by transaction costs. The stocks with the strongest reversal are small, illiquid, and expensive to trade. After realistic trading cost estimates, profitability drops substantially, making it difficult to capture in practice.
Role in factor models and risk models
Short-term reversal is generally not included in academic factor models (fama-french-three-factor, fama-french-five-factor, q-factor-model) because it is considered a microstructure phenomenon rather than a priced risk factor. However, commercial risk models like MAC3 include it as a style factor, reflecting its importance for explaining short-horizon return covariance.
Relationship to other anomalies
Short-term reversal and momentum are conceptually distinct. Momentum sorts on 12-2 month returns (skipping the most recent month precisely to avoid reversal contamination). long-term-reversal operates at 3-5 year horizons and reflects a different mechanism (overreaction to long-run performance).